The Swiss currency peg is like an expensive Swiss watch: technically impressive but costing astronomical sums of newly printed central bank money. So far, it’s working.
The Swiss central bank put a limit last September on appreciation of its already much appreciated currency, which is up 25 per cent since 2008. Refugees from the euro keep knocking on that 1.20-francs-per-euro door, threatening to push the franc much higher. The Swiss fear that would push the country into recession and severe deflation.
The Swiss National Bank’s defence is more that of a Las Vegas gambler than a horologist. But the SNB can print its own Swiss franc chips. Its monetary base has almost trebled in the past year, to approach 40 per cent of GDP – double that of the U.S Federal Reserve. The liberally printed francs have been mopping up euros: Foreign currency reserves soared to 303.8 billion francs ($327.4 billion) in May, up by 66.2 billion Swiss francs in May alone.
In theory, the additional funds will lead to inflation. But thanks to liquidity-draining operations from the central bank, the money is not hitting the economy. Broad M3 money supply is up just 6.3 per cent in the past year and the inflation rate is negative 1 per cent. There is also a danger of currency losses, but the SNB is diversifying its reserves. The successfully defended peg and the fall of the euro against the dollar mean it looks OK for now.
The real worry is how the SNB would respond to a worse euro crisis. Capital controls, recently mentioned by Thomas Jordan, the SNB governor, would be an emergency, probably not very effective and almost certainly temporary step that would hamper the Swiss financial sector.
Eventually there will be a strong, safe currency at Switzerland’s door associated with an economy like theirs but bigger, called Germany. The problem is that it’s hard to put a time on when that day, and an end to currency poker, will come. Until then the horologists turned gamblers can’t afford to blink.